Truly exceptional businesses tend to make for truly exceptional investments.
That’s especially true over a longer period of time.
Buying into a truly exceptional business at an opportunistic valuation only intensifies things.
Intelligent investing isn’t that difficult.
When it comes right down to it, it’s all about investing in truly exceptional businesses at appealing valuations.
One investment strategy excels at playing this out.
It’s dividend growth investing.
The very nature of this strategy funnels an investor into truly exceptional businesses.
That’s because only the best of the best can pay out reliable, rising cash dividends for decades on end.
After all, it requires a world-class company to produce the reliable, rising profit necessary to sustain that behavior.
You can see what I mean by perusing the Dividend Champions, Contenders, and Challengers list.
This list has compiled invaluable data on more than 700 US-listed stocks that have increased their dividends each year for at least the last five consecutive years.
It’s unlocked amazing financial success for me.
I was able to retire in my early 30s.
My Early Retirement Blueprint shares how I was able to accomplish that.
I now control a six-figure portfolio, which I call the FIRE Fund – it’s chock-full of high-quality dividend growth stocks.
This portfolio produces enough five-figure passive dividend income for me to live off of.
While the strategy does a great job of funneling the investor into the right businesses, valuation is also critical.
Price is only what you pay. It’s value that you actually get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value. And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
It’s protection against the possible downside.
Investing in truly exceptional businesses, and doing so when valuation is favorable, sets the investor up for truly exceptional investment performance over the long run.
Fortunately, the valuation part of this equation isn’t that difficult to figure out.
Fellow contributor Dave Van Knapp has introduced Lesson 11: Valuation, which goes a long way toward demystifying valuation.
It’s part of a larger series of “lessons” on dividend growth investing as a whole, and it includes a valuation template that can effectively be used to value pretty much any dividend growth stock.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
JPMorgan Chase & Co. (JPM) is a financial holding company that operates as one of the largest financial institutions in the United States, with over $3.5 trillion in assets. They offer various financial products and services across traditional retail and commercial banking, asset management, and investment banking.
Founded in 1799, the bank is now a $460 billion (by market cap) global financial juggernaut that employs almost 300,000 people.
The company operates across four major business lines: Consumer & Community Banking, 42% of FY 2020 net revenue; Corporate & Investment Bank, 40%; Asset & Wealth Management, 12%; Commercial Banking, 8%. They also have a Corporate business segment that results in insignificant negative revenue.
JPMorgan Chase has a fabled corporate history, intertwining with moguls such as J.P. Morgan, John D. Rockefeller, Thomas Edison, and Andrew Carnegie.
This is such a truly massive and important financial institution, the United States would have a difficult time coping if it were to suddenly disappear.
From retail branches to credit cards to the financial markets, JPMorgan Chase touches just about every facet of US finance.
Simply put, it’s a critical part of the American financial infrastructure.
Here’s how Morningstar describes the bank:
“JPMorgan Chase is arguably the most dominant bank in the United States. With leading investment bank, commercial bank, credit card, retail bank, and asset and wealth management franchises, JPMorgan is truly a force to be reckoned with.”
If you think the economy of the United States will prosper over the long run, then you have to simultaneously believe that JPMorgan Chase will prosper over the long run. With a symbiotic relationship in place, it’s nigh impossible to separate the two.
I can think of no better country to bet on for the long run, which puts JPMorgan Chase in an excellent position to thrive for years to come.
That should, in turn, translate to higher profits and dividends for shareholders.
Dividend Growth, Growth Rate, Payout Ratio and Yield
The bank has already increased its dividend for 10 consecutive years.
And with the recent announcement that they plan on increasing the dividend by 11.1% with the next dividend declaration, that track record is about to get longer.
Meantime, the five-year dividend growth rate of 15.4% is stellar.
This yield easily beats the market, and it’s almost 30 basis points higher than the stock’s own five-year average yield.
The low payout ratio of 31.7% easily protects the new $1.00/quarter dividend.
I like dividend growth stocks in what I refer to as the “sweet spot” – that’s a yield of between 2.5% and 3.5%, paired with a high-single-digit (or better) dividend growth rate.
This stock is right in the sweet spot.
Revenue and Earnings Growth
These are really great dividend metrics.
As great as they are, though, they’re looking at what’s already come to pass.
However, investors risk today’s capital for tomorrow’s rewards.
It’s future business growth and dividend raises that we care most about.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will later greatly assist with the valuation process.
I’ll first show you what the company has done over the last decade in terms of top-line and bottom-line growth.
Then I’ll reveal a professional prognostication for near-term profit growth.
Amalgamating the proven past with a future forecast should give us a pretty good idea as to where the company is going from here.
JPMorgan Chase has grown its revenue from $97.234 billion in FY 2011 to $119.543 billion in FY 2020.
That’s a compound annual growth rate of 2.32%.
Not bad top-line growth here, considering the size and maturity of the business.
Earnings per share expanded from $4.48 to $8.88 over this period, which is a CAGR of 7.90%.
A high-single-digit EPS growth rate like that is rather solid.
But this business is stronger than it looks, as FY 2020 was undoubtedly a terrible year for bank earnings. Because they had to set aside a significant amount of loan loss reserves during 2020, due to pandemic-induced economic uncertainty, EPS for the year took a major hit.
If we were to back things up a year, or move things forward one year, their long-term EPS growth picture would look a lot brighter.
For perspective on that, the nine-year CAGR for EPS between FY 2011 to FY 2019 is 11.52%. Furthermore, TTM EPS is over $12.00.
Looking forward, CFRA forecasts that JPMorgan Chase will compound its EPS at an annual rate of 5% over the next three years.
This is an extremely cautious take on the bank’s near-term EPS growth potential, in my view.
On one hand, CFRA has this to say: “We see JPM as the best-managed large, diversified bank, poised to benefit from higher consumer and commercial loan activity.”
On the other hand, CFRA rightfully notes persistently low interest rates and reduced loan demand as major headwinds.
I think it’s wise to be prudent regarding a financial institution in this environment, especially since so much uncertainty remains.
However, recent quarters have shown a serious rebound in JPMorgan Chase’s numbers, with the release of loan loss reserves springing the bank’s EPS back to life.
With the economy normalizing, loan demand should follow suit.
Plus, rates are set to rise within the next two years.
Moreover, JPMorgan Chase isn’t as heavily dependent on interest rates as some other competitors. They have substantial exposure to capital markets.
In my view, JPMorgan Chase stands to do a lot better than CFRA is giving them credit for.
But even if they were to put together a meager 5% EPS CAGR over the next few years, that’d still be enough to power high-single-digit dividend growth.
And with a near-3% starting yield, that’s a pretty appealing combination of yield and growth.
Financial Position
Moving over to the balance sheet, they have one of the largest and most complex financial makeups of all institutions.
This can make it difficult to decipher exactly what’s going on.
But it gives them scale in an industry where scale matters, and scale proves its value in times of trouble (such as over the last year).
The bank has $3.4 trillion in total assets against $3.1 trillion in total liabilities.
JPMorgan Chase retains the following credit ratings for its senior unsecured debt: A2, Moody’s; A-, Standard & Poors; AA-, Fitch. These ratings are well into investment-grade territory.
Profitability is quite robust.
Over the last five years, the firm has averaged annual net margin of 25.30% and annual return on equity of 11.73%. Net interest margin came in at 1.98% for last fiscal year.
There is a lot to like about this bank. It’s an absolute powerhouse in every category it could possibly be a powerhouse in.
And with enormous economies of scale, high switching costs, unique financial expertise, and built-up relationships, the company benefits from durable competitive advantages.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
I see all three of these risks as elevated for JPMorgan Chase’s business model.
Banks are directly exposed to economic cycles. Any lingering scars on the economy from the pandemic-induced recession could harm JPMorgan Chase.
While their sheer size is an advantage, it also limits their growth prospects by virtue of the law of large numbers.
Low rates remain persistent and doggedly challenge the bank’s profitability.
Even with these risks, JPMorgan Chase strikes me as a compelling long-term investment idea for dividend growth investors.
That’s particular true with the valuation being attractive…
Stock Price Valuation
The stock is trading hands for a P/E ratio of 9.98.
That’s obscenely low in this market, although some of what should have been last year’s earnings are now showing up this year.
Still, that’s quite remarkable.
The P/B ratio of 1.8 is admittedly on the high end of what a large US bank can typically command, but I think this bank deserves a premium.
And the yield, as shown earlier, is measurably higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.
This DGR is about as high as I’ll go for a bank.
Again, though, if there’s any bank that deserves a premium and the benefit of the doubt, it’s this bank.
If we look at what this company has done over the last decade in terms of profit growth and dividend growth, this is not a high bar to clear. Indeed, the upcoming dividend increase, at over 11%, is well over this level.
And with the payout ratio being so low, they can easily afford to grow the dividend at a high-single-digit rate for years to come.
The DDM analysis gives me a fair value of $172.00.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
This stock looks cheap to me, even after a vigilant valuation.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates JPM as a 3-star stock, with a fair value estimate of $143.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates JPM as a 4-star “BUY”, with a 12-month target price of $179.00.
I came in very close to where CFRA landed. Averaging the three numbers out gives us a final valuation of $164.67, which would indicate the stock is possibly 10% undervalued.
-Jason Fieber
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Note from D&I: How safe is JPM’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 60. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, JPM’s dividend appears Borderline Safe with a moderate risk of being cut. Learn more about Dividend Safety Scores here.
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